Yield Farming – How to Boost Your Income From DeFi

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Yield Farming - How to Boost Your Income From DeFi
Yield Farming - How to Boost Your Income From DeFi

You could say that seeking lifelong fulfillment is what yield farming is all about. However, as the saying goes, it’s always easier said than done. But within the context of the decentralized finance (DeFi) continuum, blockchain assets present unprecedented prospects for yield farming.

Yield farming is the practice of lending or staking cryptocurrencies in exchange for benefits like interest. In order to calculate their returns, yield farmers use annual percentage yields (APY). Farming for yield has the potential to be very rewarding, but it is also very dangerous.

Farmers who are interested in increasing their crop production can use more sophisticated strategies. For instance, yield farmers can continuously switch their cryptocurrency holdings between several loan platforms to maximize their profits.

Continue reading this guide to learn more about yield farming and how to increase your income.

What is Yield Farming – A Quick Intro

Yield farming is a technique of generating interest on your cryptocurrencies, similar to how you’d collect interest on any money in your savings account. Likewise, yield farming entails locking up your cryptocurrency for a period of time, or staking, in exchange for interest or other benefits like additional cryptocurrency.

This income is typically shown as an Annual Percentage Yield, or APY, percentage, also known as an Effective Annual Rate (EAR). It gauges the potential return on an original investment.

The amount lent out with traditional loans from banks is repaid with interest. The idea behind yield farming is the same: cryptocurrency that would typically just be sitting in an account is lent out in order to make money.

Annual percentage yields (APY) that can reach triple digits have been produced by yield farmers since the practice of yield farming started in 2020. 

The protocols and coins earned are subject to extreme volatility and rug pulls, in which developers abandon a project and steal investors’ money, so this potential return carries a high risk.

So How does yield farming work?

By depositing coins or tokens in a decentralized application, or dApp, yield farming, often referred to as liquidity farming, enables investors to make a return on their investment. Cryptographic wallets, DEXs, decentralized social media, and other applications are examples of dApps.

Other investors can then borrow the coins through the dApp to utilize for speculation, where they try to profit off of dramatic fluctuations they anticipate in the coin’s market price.

Decentralized exchanges (DEXs) are typically used by yield farmers to lend, borrow, or stake coins in order to earn interest and speculate on price fluctuations. Yield farming across DeFi is facilitated by smart contracts — bits of code that automate financial agreements between two or more parties.

The true benefit of the arrangement is that investors who lock up their cryptocurrency coins on the yield-farming system can earn interest and frequently more cryptocurrency currencies. The investor’s returns increase if the value of those extra coins increases.

Types of Yield Farming

There isn’t much to think about in traditional banking other than making a deposit and receiving interest. The bank will then select how to allocate those money throughout its range of financial products.

There are no banking institutions in DeFi. Smart contracts recorded on blockchain networks have taken their place, and a variety of yield farming alternatives are available:

Liquidity provider 

To provide trading liquidity, users deposit two coins to a DEX. Exchanges charge a nominal fee to swap the two tokens which is paid to liquidity providers. Sometimes, fresh liquidity pool (LP) tokens can be used to pay this cost.

Staking

In the realm of DeFi, there are two types of staking. The primary implementation is on blockchains using proof-of-stake, where a user receives interest in exchange for pledging their tokens to the network as security.

The second is to stake LP tokens obtained by providing liquidity to a DEX. Because they are compensated for providing liquidity in LP tokens, which they may later stake to earn more interest, this enables users to earn yield twice.

Lending and borrowing

Providers of liquidity can place their cryptocurrency funds in pools for other traders who prefer to borrow tokens rather than exchange them. Farmers with high yields frequently act as both borrowers and lenders.

This is common since one might yield-farm using borrowed money and rely on volatile assets to increase in value to cover the cost of borrowing.

Yield Farming Returns Calculation

Annualized yield returns are commonly used. The anticipated returns are estimated over the course of a year. Annual percentage rate (APR) and annual percentage yield (APY) are two often used measures. APR does not take into account compounding (reinvesting gains to create higher returns), whereas APY does.

Remember that the two measures are only forecasts and estimates. Even short-term benefits are difficult to predict with precision. Why? Yield farming is a fiercely competitive, fast-paced sector with constantly shifting incentives.

If a yield farming approach works for a while, other farmers will swarm to use it, and it will eventually stop producing large profits.

DeFi will have to develop its own profit calculations because APR and APY are outdated market measurements. Because of DeFi’s rapid pace, weekly or even daily expected returns may make more sense.

Is yield farming risky?

Yield farming is a complex operation that puts both borrowers and lenders at risk. Users incur a higher risk of momentary loss and price slippage when markets are volatile. Rug pulls, regulatory hazards, and volatility are all concerns involved with yield farming.

Risk farming entails a lot of dangers that investors should be aware of before getting started. In the DeFi yield farming industry, scams, hacks, and losses due to volatility are widespread. The first step for anyone interested in using DeFi is to research the most reliable and tested systems.

To Wrap Up

In order to earn interest or additional bitcoin, yield farming entails staking, or locking up, your money. Yield farming will become more prevalent as cryptocurrency gains popularity.

If you’re looking for a means to generate some passive income without making a significant financial commitment, consider putting some of your cryptocurrencies into a liquidity pool or platform that has been around for a while and has earned your confidence to see how much it can generate.

While yield farming offers the potential for enormous rewards, it is also incredibly risky. As proven by the numerous known swift price swings in the cryptocurrency markets, a lot may occur while your bitcoin is locked up.

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